A Roadmap for September Expiration Week

Should investors be doubly cautious during September expiration?

Senior Vice President of Research
Sep 13, 2021 at 9:06 AM
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“… a move above 4,475 would bring the next resistance area immediately into focus, with the round half-millennium 4,500 level a potential barrier. Moreover, the 4,507 level is a round 20% above last year’s close. Round-number year-to-date (YTD) percentage returns are sometimes important, marking resistance or hesitation areas…the SPX chopped around its round 10% YTD gain for about a month-long period in April and May.”

          -Monday Morning Outlook, August 30, 2021

“…here we are, stocks have entered a seasonally weak periodthe S&P 500 Index (SPX—4,535.43) may have reason to stall, as the index trades at a level that represents a round 300% return over the past 120 months, or rolling 10 yearsFriday saw a bearish ‘tri-star doji’ pattern, which occurs when the opening and closing prices are the same or about the same for three consecutive days. These are multi-day reversal patterns that have signaled short-term weakness a few times already this year, including late April.”

          -Monday Morning Outlook, September 7, 2021

If you are a large-cap technology investor with sizeable investments in the Invesco QQQ Trust Series (QQQ—376.59) or the Technology Select Sector SPDR Fund (XLK—156.63), two exchange-traded funds that have traded at all-time highs in a narrow range during the past two weeks, you probably have not noticed the pullback in the broader market, as measured by the S&P 500 Index (SPX—4,458.58). 

The SPX pulled back from a general area that I observed could create short-term challenges for the index, as it approached a round 20% above last year’s close, plus a level that is coincident with a round 300% 10-year rolling return, and the 4,500 half-millennium level. The SPX did push above 4,500 and 4,507, albeit briefly and coincident with a bearish short-term technical pattern emerging that also reared its ugly head in January, February and late-April.

Specifically, as I mentioned in my concluding remarks last week, the SPX’s candle on Friday, Sept. 3 completed a three-day Japanese candlestick pattern, known as a “tri-star doji.” This pattern is defined by three consecutive days in which the underlying closes at or around its opening price. 

Such patterns typically hint at a reversal, which in this case, a pullback from the SPX’s all-time highs, achieved in the first trading days of September, which is well-known for its weak seasonality.

When the “tri-star doji” patterns surfaced in January, February, and April, they preceded mild SPX declines from around the top rail of a channel that the SPX has been trading mostly within since mid-November last year. The declines pushed the SPX to levels slightly below the lower rail of this channel. In fact, trading below the lower rail lasted only a few days at most, as robust rallies from the 50- or 80-day moving averages quickly pushed the SPX back into the bullish channel.

If there is work to be done with respect to the current decline, the first level of support during September expiration week is in the 4,475 area, which is both double the SPX’s 2020 closing low and in the lower rail of its channel, which ranges between 4,455 to start the week and 4,475 at Friday’s close. 

If a move below this rail is in the cards, which occurred after the January and February “tri-star doji” patterns, the rising 50- and 80-day moving averages could be supportive, which come into the week at roughly 4,425 and 4,350, respectively.

mmo chart 1

Just like last month, the CBOE Market Volatility Index (VIX) experienced a pop around expiration. Just as it pulls back to big put open interest strikes, it is as if there is a concerted effort to ensure most or all the put open interest at put-heavy strikes expires worthless.”

          -Monday Morning Outlook, August 23, 2021

“…volatility has emerged as a semi-predictable occurrence recently, a presence once recognizable only to specialists but now drawing the attention of an ever-larger crowd on Wall Street… What all these things have in common is they happened around the third Friday of the month

            -Bloomberg, August 28, 2021

Just as weak September seasonality has been a theme in the media, another emerging theme I am noticing is weakness during expiration week. Bloomberg News, as excerpted above, picked up on it late last month, and CNBC television made light of expiration week weakness during its programming last Thursday. It may be coincidental, but I find it noteworthy that during this period of weak seasonality, at least four brokerages turned short-term cautious last week. 

It is very tempting to draw bullish contrarian conclusions from the caution that is being broadcast, as these brokerages became wary last week amid well-known negative seasonality factors, but within the context of a bull market.

During the past few months, I have written about the expiration weakness, especially as it portends to the huge build in VIX futures put open interest from month to month this year. My observation has been that CBOE Market Volatility Index (VIX—20.95) futures suddenly rally from the largest put open interest strikes around expiration, causing these contracts to expire worthless. In prior years, we would see the opposite occur, as it was not unusual to see 90% or more of the call open interest on VIX futures expire worthless.    

In fact, September’s VIX futures open interest configuration looks a lot like the open interest configuration of prior months this year (September VIX expiration occurs on Wednesday morning, unlike Friday afternoon for most other index and equity options). 

The good news for bulls is that at Friday’s close, the VIX September futures contract comes into the week above the 18 level. This is important because the VIX’s heaviest put open interest strikes are at 15 through 18. With Friday’s close at 20.95, there is room for the September volatility futures contract to decline to 18 or higher upon Wednesday morning’s settlement, paving the way for a plethora of VIX futures put open interest at the 15 through 18 strikes to expire worthless, even if stocks rally or are at least trading above Friday’s close at Wednesday morning’s settlement. 

Moreover, per the second graph below, I don’t see anything in the SPDR S&P 500 ETF Trust (SPY—445.44) open interest configuration that will cause unusual volatility from an option open interest perspective. There could be a little bit of additional selling tied to the heavy call open interest at the 450 strike, since most of these contracts were bought (to open). However, such selling would push the SPY to levels that have been supportive in 2021 and we there is not an immediate threat of delta-hedge selling related to big put open interest strikes acting as magnets.  

I point this out from the perspective of trading with a contrarian mindset this week. While nothing is a guarantee, there are strong supporting factors in the option market to take the other side of the expiration week increases in volatility that have been well documented by the financial media in recent weeks.   

MMO chart 2

MMO chart 3

Todd Salamone is Schaeffer's Senior V.P. of Research

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